Government of India Volume I: Analysis and Recommendations

Table of Recommendations 11.1 Objective of monetary policy
MONETARY POLICY
1. The Central Government, in consultation with the central bank Chairperson, would release a Statement establishing
the specifics of its predominant objective, as well as other secondary objectives (if any). In addition,
if there are multiple secondary objectives, these would be prioritised in the Statement. These would be
medium-term objectives.
2. The Statement would also define what constitutes a substantial failure in achieving the objectives.
3. The Statement would be released into the public domain.
At the same time, there is a strong case for independence in making this decision.
If a central bank lacks independence, it comes under pressure to cut rates in the period
preceding elections. This tends to kick off increased inflation after elections. The lack of
independence at a central bank is thus associated with reduced fairness in elections and
enhanced macroeconomic fluctuations.
Achieving independence of a central bank requires appropriate institutional design.
One key element is a MPC that controls all instruments of monetary policy. Such an arrangement
yields improved decisions by pooling the thinking and analysis of multiple
members. In addition, it reduces the extent to which the head of a central bank can be
pressured to cut rates in accommodating the government. The Ministry of Finance, as a
representative of the Central Government, has the right to be heard in MPC meetings, but
it should have no voting member in the MPC. This would remove political and electoral
considerations from the conduct of monetary policy.
The strongest form of independence, among all the agencies for which bills have
been drafted by the Commission, is found with the central bank. This requires a commensurately
strong accountability mechanism. Strengthening accountability, alongside
enhanced independence, is a core theme of the Commission.
11.1. Objective of monetary policy
The Central Government, in consultation with the head of the central bank (refered to
as Chairperson in this chapter), would determine the predominant objective of monetary
policy, as well as other secondary objectives (if any) through a formal process shown
in Table 11.1. The specifics of the objectives would be articulated in a Statement, which
would be released into the public domain. Each objective would be a quantifiable, numerical
target. Secondary objectives would be prioritised and could be pursued subject
to successful delivery of the predominant objective. These would be medium-term targets.
The Statement would also quantitatively define what constitutes a substantial failure
in achieving these objectives.
While the Statement would be issued every two years, it is expected that the substance
of the Statement would be modified only occasionally, thus giving stability to
monetary policy strategy.
11.2. Powers of the central bank
In order to perform its monetary policy functions and play its role as the lender of last
resort, the central bank will have the following powers:
1. Issuance of Legal Tender Currency: The central bank would be the sole agency authorised
to issue currency.
2. Banker to Banks: In order to facilitate smooth inter-bank transfer of funds, or to
make payments and to receive funds on their behalf, banks need a common banker.
104 FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION